How to Assess Costs and Benefits

Thinking about making a major decision for your small business? A cost-benefit analysis can help you determine which way to go.

Once you’ve compiled your income statement, balance sheet, and cash flow statement, you can use this recording of your business’ financial position to analyze the costs and benefits of decisions. Whether considering a large equipment purchase or hiring your first employee, conducting a thorough cost-benefit analysis can help you make informed decisions that will have long-term impacts to your business.

What is a cost-benefit analysis?

Simply put, a cost-benefit analysis looks at money in and money out to help you reach a decision and highlight the pros and cons of a particular action. This analysis looks at a potential action, considers the financial outcomes, and helps you reach a decision.

Gut feeling vs. hard data: Cost-benefit analysis helps remove emotion from big decisions, letting numbers guide the way.

How do I create a cost-benefit analysis?

The Harvard Business School offers an in-depth guide on how to create an effective cost-benefit analysis, but we’ll outline the steps to create a cost-benefit analysis below.

1. Decide benchmarks for success.

Do you want this project or decision to break even or generate revenue? Do you want the costs to be below a certain threshold? Be clear about the success metrics you hope to achieve.

2. Identify hard costs.

This project or decision will likely have cash outlays. How expensive is the decision/project? Direct hard costs are the immediate items related to the decision/project — materials, shipping, storage, inventory, etc. Indirect hard costs can be utilities, administrative expense, and other elements related to doing business after the project/decision is completed.

3. Identify soft costs.

Soft costs are often an area entrepreneurs underestimate. This includes intangibles like your time, opportunity costs, and any other intangible assets.

4. Tag a dollar value to each cost.

By predicting the costs associated with each side of a decision, you can see expenses that may otherwise be hidden.

5. Don’t forget return on investment.

Use the data you've gathered to identify trends and patterns in your industry and target market. This can help you make informed decisions about your business' products or services and marketing strategy. (Using data visualization can help you more easily understand and communicate insights from your data.)

6. Use the insights you've gained to inform your business plan.

Some decisions may take a while to pay off, so when you’re conducting your analysis, be sure to assign a value to the return on investment that may come from a particular action (or inaction).

Why would I want to create a cost-benefit analysis?

As a small business owner, sometimes it is best to go with your gut instinct. But when it comes to decisions with major financial upside or downside, assessing your options with a cost-benefit analysis can help remove the human element from the situation. Rather than letting emotions take the wheel, you’ll be looking at hard numbers and data to evaluate the situation.